“The danger that bond prices drop from here is very, very
real so you need to get out of those things while you’ve got a
chance,” said Nicholas Smith, a Tokyo-based strategist at CLSA.
“The government is saying run don’t walk.”

Abe requested in June that the Government Pension
Investment Fund, the world’s largest pool of pension assets,
bring forward steps to alter the allocation of its 126.6
trillion yen ($1.22 trillion), 55 percent of which was in
domestic bonds on March 31. Japan’s 10-year debt yield was 0.51
percent, or 1.16 percentage points below the estimated dividend
yield for the Nikkei 225 Stock Average on Aug. 25 and the gap
was the widest in 16 months two weeks earlier.

Unprecedented Bank of Japan buying of sovereign notes
offers investors a window to sell the debt and move into other
investments such as domestic shares, which are “stupid cheap,”
said Smith. The Topix index has declined 1.3 percent this year
after soaring 51 percent in 2013 as equity investors become
impatient to see structural reforms promised by Abe.

The price-earnings ratio of shares on the Topix index was
15.6 times, compared with about 18 times for the Standard &
Poor’s 500 Index, and 20.5 times for the STOXX Europe 600 Index,
according to data compiled by Bloomberg.

JGB Holdings

Domestic ownership of JGBs has increased to 91.6 percent at
the end of March from 91.4 percent in December 2012, when Abe
took office, according to BOJ data. By contrast, Japanese
financial institutions and individuals were net sellers of
domestic stocks in the year to March 31, while overseas buyers
boosted holdings of equities on Japanese bourses to a record
30.8 percent, Tokyo Stock Exchange data show.

“Japan has increased its exposure to bonds and sold the
equity to the foreigner,” in contrast to Kuroda’s prediction
that local investors will shift from debt to riskier assets,
according to Smith. He has been in Japan since 1987 and joined
CLSA in August 2011 after working with Jardine Fleming
Securities in the 1990’s and a four-year stint at hedge funds,
according to biographical information provided by CLSA.

The gap between Japan’s dividend and bond yields is 10
basis points from the widest since April 2013, reached on Aug.
8. In the U.S., 10-year Treasuries have a 0.42 percentage point
yield premium over equity dividend yields as the Dow Jones
Industrial Average climbs for a sixth straight year.

GPIF Outlook

All 10 fund managers, strategists and economists in a
Bloomberg News survey expect GPIF to trim its holdings of
domestic debt, with six projecting a cut to 40 percent from 55
percent at the end of March. The fund will boost its Japanese
stocks target to 20 percent from 16 percent, according to the
median estimate.

“Japan’s finances are in a very severe state so unless
drastic action is taken in the medium- to long-term, it will be
a very dangerous situation,” said Fumio Nakakubo, chief
investment officer for Japan at UBS AG’s Wealth Management
division, at a seminar in Tokyo today. “For the time being, it
is unlikely that Japan will default,” said Nakakubo, who cited
the high level of assets owned by the Japanese government,
domestic bond ownership levels, and potential avenues for
raising additional taxes in a crisis.

Property Prices

The BOJ is trying to drive up property prices in Japan so
that banks can lend against property and get the economy going
again, according to Smith. Japanese lenders increased total
loans 4.3 percent in the year ended March 31 to 499.3 trillion
yen, according to the the Japanese Bankers Association.

Land prices in Japan’s three largest metropolitan areas
gained for the first time in six years. The value of land in
Tokyo, Osaka and Nagoya was on average 0.7 percent higher as of
Jan. 1 from 12 months earlier, compared with a 0.6 percent
decline in the previous year, the Ministry of Land,
Infrastructure and Transport said in March.

Japan’s poor economic fundamentals, in addition to the
BOJ’s buying of about 7 trillion yen of sovereign notes a month,
are supporting debt prices, according to Tadashi Matsukawa, head
of fixed-income investment at PineBridge Investments Japan Co.
in Tokyo.

The nation’s economy shrank an annualized 6.8 percent in
the three months through June, the sharpest contraction since
the first quarter of 2011, after the government raised the sales
tax in April to 8 percent from 5 percent. A Nikkei survey
published this week showed that 63 percent of the public oppose
raising the levy to 10 percent next year as planned.

No Escape

“Japanese institutional investors such as banks and
insurance companies have no real avenue for escape,” said
Takafumi Yamawaki, chief rates strategist at JPMorgan Chase & Co
in Tokyo. “The level of risk that they can take is limited so
they won’t make large portfolio changes.”

The 10-year Japanese bond yield is forecast to climb to 0.9
percent by the fourth quarter of next year, according to
analysts surveyed by Bloomberg. The yen fell 18 percent against
the dollar last year in the wake of the BOJ’s stimulus, while it
has strengthened 1.4 percent so far in 2014 to 103.89 as of 4:21
p.m. in Tokyo.

Japan’s sovereign-bond risk is at 38 basis points, near the
lowest since 2008 of 34.5 touched on June 19, according to
credit-default swap prices from data provider CMA. One basis
point is 0.01 percentage point.

“While the 10-year JGB may be expensive, that is not to
say that we’re going to see the bursting of some kind of credit
bubble, and prices diving from here soon,” said PineBridge’s
Matsukawa. “Japan’s economy is performing poorly.”